Wake-up call over interest rates peril

WAKE-UP up calls must be urgently sounded to help people plan how to cope with increased borrowing costs amid the prospect of the end of rock-bottom interest rates, a think-tank has argued.

The Resolution Foundation warned that even a "relatively benign" move away from the current rate could double the number of households facing repayment problems in the coming four years.

Its projections suggest the number of "highly geared" mortgage holders who are spending more than one third of their income on repayments could balloon from 1.1 million currently to 2.3 million by 2018, equating to around one in four households with a mortgage.

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Meanwhile, the number of households in the more severe situation of "debt peril", meaning they are spending over half of their income on all forms of debt repayments could increase from 0.6 million to 1.1 million.

Both scenarios are based on assumptions that the Bank of England base rate, which has been at a historic 0.5% low for over five years, will approach 3% by 2018, in line with market expectations.

The country needs "shaking from its complacency" and lenders should be upping efforts to identify and help people who would be put at risk by a rise in interest rates, including those not currently in arrears, the report argued.

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The Financial Conduct Authority (FCA) should force lenders to contact around two million mortgage holders who are the most vulnerable to interest rate rises "as a matter of urgency", the report said.

This group, who should also be referred for independent money guidance, would include people currently undergoing forbearance measures, those who have previously had arrears problems but recovered as well as people who took out self-certified, high loan-to-value or high loan-to-income mortgages before the financial crisis.

They should be encouraged to undertake a "financial MoT" and consider how their repayments would go up in the light of different plausible interest rate increases, the report said.

This initiative would be similar to that involving home owners on interest-only mortgages who have been contacted by lenders amid fears that many do not have enough money put aside to pay back their loan when it ends.

The report also estimates that around 800,000 "highly geared" borrowers may become mortgage prisoners as interest rates rise, because tighter lending conditions mean they have no option but to stay on their existing lender's standard variable rate (SVR).

Toughened mortgage lending rules came into force in April which mean that lenders have to question both home buyers and people looking to remortgage in more depth about their spending habits in order to work out whether they can afford their home loan.

The report, titled Hangover Cure: dealing with the household debt overhang as interest rates rise, said that the FCA should require lenders to justify any increase to their SVR with specific reference to changes in their funding costs to prevent them taking advantage of their potential monopoly position over mortgage prisoners.

Lenders should also be obliged to offer a medium-term fixed-rate mortgage deal, perhaps for five years, to give mortgage prisoners at least one alternative to being parked on an SVR, the report said.

The Government should also set up a "help not to be repossessed" scheme, enabling borrowers who find their mortgages have become unaffordable to switch to a shared ownership scheme, the report added.

The Resolution Foundation gave indications of how changes in mortgage rates could impact on repayments.

A rate of 3.2%, which corresponds with current average mortgage rates, means someone with a 25-year mortgage of £150,000 pays £727 a month.

But if this rate increases to 3.7%, the monthly cost is £767, amounting to around £480 a year more. If the rate jumps another percentage point, to 4.7%, the monthly cost is £851 and the mortgage holder pays in the region of £1,488 more a year than they would on a rate of 3.2%.

Moving the mortgage rate up to 5.7% means the mortgage holder pays £939 a month, or around £2,544 a year more than on a rate of 3.2%.

The Foundation said these figures do not reflect exactly what would happen due to given changes in the base rate because lenders would respond differently in terms of how this feeds into their mortgage products.

Matthew Whittaker, chief economist at the Resolution Foundation and co-author of the report, said: "It would be a serious mistake to think that the legacy of problem debt built up in the pre-crisis years will simply evaporate with a return to economic growth.

"The magnitude of the stock of debt is simply too large, given expectations that income growth will be gradual at best.

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"And while the mortgage market largely remains competitive, tighter lending criteria means that some highly-stretched borrowers face limited choices. There is a pressing need for regulation to respond to this new context."

Yesterday, Bank of England governor Mark Carney appeared to dampen the prospect of an imminent hike in the base rate by shifting the focus for any decision on to pay growth. He also reiterated that when rates do start to rise, the shift will be "gradual and limited".

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